By Lucas Scholhamer
Some are calling it the most revolutionary energy find since the Spindletop gushers sparked the Texas oil boom of 1901. Others are going even further, claiming it could be the single most significant economic development in the history of the Lone Star State. Any way you look at it, the Eagle Ford shale, spanning 14 counties across south Texas, has huge potential to make an impact on the fossil fuel industry.
The under-hyped Eagle Ford shale covers over 6 million acres, with some experts suggesting that the reserves could eventually yield in excess of 10 billion barrels of oil. The number of drilling permits issued has skyrocketed in the past year and a half, from a total of 94 issued in 2009 to well over 1,000 in 2010. The area’s high percentage of carbonate shale means that more oil can potentially be produced than natural gas, and technological advancements like horizontal drilling will help exploit the area’s resources to the fullest extent. Some of the big-name players, including energy giant ExxonMobil (XOM) and Anadarko Petroleum Corp. (APC), have already staked out their claims in this arena. However, there are a handful of other interesting companies looking to profit from this fascinating fossil fuel find. Investment Underground examines 5 of them:
EOG Resources (EOG): First on the list is EOG Resources. The Houston-based oil company currently has rights to the greatest amount of land in Eagle Ford, totaling 520,000 net acres. EOG focuses on exploration and production of oil and natural gas, primarily in North America. Shares depreciated 2.43% to $104.25 at the time of writing, with a 52-week range from $85.42 to $121.44. With a market cap of $28 billion, EOG is no small company, and buyers face a high barrier to entry. However, for the 12th straight year, EOG approved an increase in its common stock dividend for 2011, which will grow 3% to $0.64 per share (or 0.60%). The company reported a net income of $160.7 million for FY 2010, down considerably from last year’s $546.6 million total, although revenue generated from liquids surpassed those from natural gas for the first time in the company’s history.
I recommend buying this stock, although it would be wise to wait until we see if it will fall through its support around $103. If this is the case, it may continue to drop to its 200-day moving average just over $99.00. However, the company has positioned itself well for profitability in the future. EOG has switched directions quickly, now focusing on increasing the weight of its liquids portfolio to capitalize on projected increases in demand for crude oil, condensate, and natural gas liquids. In fact, EOG’s liquid production increased by 33% in FY 2010. Also, the company’s early-moving strategy has netted them significant plots of land in some of the hottest emerging areas (like the Eagle Ford and Bakken shale finds) for a low price. At this point in time, natural gas production and reserves still account for a majority of EOG’s total production and reserves, which could put them in a good position if natural gas prices increase in the near future.
However, as EOG continues to transition the makeup of its portfolio, I am not entirely confident that natural gas proceeds will be sufficient to prevent another major loss in profits next year as the company continues to increase spending on developing liquid resources. Furthermore, the resulting weak cash flow calls into question the sustainability of EOG’s ever-increasing dividends. Nonetheless, the company’s long-term prospects are bright.
Chesapeake Energy Corporation (CHK): This Oklahoma-city based company has the second largest stake in the Eagle Ford play, with rights to 445,000 acres. Overall, CHK owns approximately 13.2 million acres, primarily in the U.S., focusing mostly on natural gas. Shares fell 1.37% to $30.20 at the time of writing, continuing to hover below the YTD high of $35.95 reached in early March. CHK has a market cap of $19.6 billion and its stock carries a trailing P/E ratio of 24.3 and a dividend yield of 0.99%. The company announced a net loss of $205.1 million in Q1, despite a $4.65 billion sale of shale gas assets in Arkansas and major growth in their production of liquids.
However, there are some bright spots for CHK. The company was recently chosen to receive the highly-regarded “Oil and Gas Investor Excellence Award for the 2010 M&A Deal of the Year” for executing a $2.2 billion joint venture transaction with CNOOC, a Chinese oil and gas company dealing with the Eagle Ford play—and who doesn’t love a little bit of good press? Furthermore, CHK has put together an impressive portfolio of holdings in emerging areas: CEO Aubrey McClendon announced that CHK currently holds leading positions in 12 of the 13 liquids-rich plays in the continental U.S., most of which were attained early on for a relatively low price. Also, many analysts are predicting a 32% year-over-year increase in revenue for Q2 up to $2.66 billion, and with a very low forward P/E ratio of 9.3, it isn’t hard to find this stock attractive. With price target estimates averaging at about $34.00, this may be a good opportunity to pick up shares, even more so if they drop below their recent support level around $29.30.
My only concern is that much of CHK’s advertised strength lies in its actual attainment and sales of prime plots of land. The value of CHK’s holdings was easily the largest bragging point during the company’s Q1 conference call, and as the real estate market for emerging plays begins to slow, simply owning the land will not be enough to please shareholders. However, the United States’ second-largest producer of natural gas and most active driller of new wells seems to have the technical knowledge and prowess to harness the full potential of their sought-after land claims, and as long as they continue to eliminate their debt (CHK reduced their debt by 25% in Q1), the company definitely has the potential for growth and profitability in the future.
Petrohawk Energy Corporation (HK): Petrohawk was one of the earliest companies to get in on the Eagle Ford shale, announcing the first commercial discovery in the region in 2008. Based out of Houston, HK focuses on oil and natural gas E&P and operates primarily in Louisiana, Arkansas, and Southeast Texas. Shares traded down 0.16% to $25.35 at the time of writing, with a P/E ratio of 97.1. In its recent Q1 report, HK announced a 12% year-over-year revenue increase reaching to $492 million, and an 11% year-over-year increase in net income, up to $44.4 million from $39.9 million last year.
I think Petrohawk is an especially attractive buy. HK has been trimming the fat to reduce its debt and concentrate the company around the development of its most profitable holdings. In the last year alone, the company has sold its remaining stake in KinderHawk Field Services LLC in Haynesville and a minority interest in its midstream business in the Eagle Ford shale play, a divestment of more than $1 billion for the quarter. HK also recently acquired 325,000 acres in the Permian Basin. With natural gas prices nearly constant and the supply increasing with the implementation of more efficient technology, HK has realized that liquids look to be more profitable in the future. Thus, they have consolidated a portfolio comprised of several leading positions in hot areas with potential to produce an abundance of liquids (such as the Permian Basin acreage and its 332,300 acres in Eagle Ford). Also, with a market cap of $7.7 billion, it is considerably smaller than the prior 2 companies we have examined. A focused, midcap company with significant reserves and holdings in valuable areas? It appears as though HK could be a potential takeover target. And given its share price in the mid-$20 range and a low P/E ratio of 15.3, HK stock looks even more attractive.
My one concern is that, if HK is indeed positioning itself to be sold, the value of its liquids-oriented portfolio is heavily influenced by changes in the price and demand of crude oil, condensates, and natural gas liquids. HK’s value as an acquisition could fall if prices for these liquids decline, ultimately making its holdings less attractive.
El Paso Corporation (EP): Next on the list is El Paso Corporation, a Houston-based company operating the United States’ largest network of interstate pipelines and producing oil and gas. EP owns 170,000 acres in the Eagle Ford play. Shares appreciated a staggering 6.27% to close at $20.17 at the time of writing. EP stock has risen steadily for the last year or so, nearly doubling its value since last May. Shares have a P/E ratio of 33.4, and EP offers a 2% dividend yield. However, on Tuesday morning, El Paso Corp. announced that it will be separating into two publicly-owned businesses before the end of 2011 by spinning off the company’s exploration and production segment. El Paso Corp. plans to retain its pipeline group, its midstream group, and a stake in El Paso Pipeline Partners, L.P. (EPB). EP also raised its earnings guidance, with an adjusted EPS of $1.00-$1.10 for FY 2011 (up from approximately $0.56).
This presents a very interesting situation. EP recently completed an $8 billion overhaul/expansion of its pipeline infrastructure, expanding its dominance in the field. While this does position them well for growth after spinning off the exploration and production portion of the business, balancing the spreadsheet after such a large investment may be difficult without the revenue of its E&P division. However, I am much more optimistic about the soon-to-be separate exploration and production company, which should be strongly positioned for growth upon becoming an independent corporation. El Paso announced Tuesday that they would be increasing their E&P capital by $300 million to a total of $1.6 billion, primarily to step up production at Eagle Ford. EP’s oil volumes are expected to increase by 35-45% over 2010 levels. There has been an overall positive attitude about Tuesday’s announcement to split the company (see the 6.27% stock price increase), so it might be a good opportunity to pick up EP stock—perhaps after a minor price correction—that could appreciate in the coming months. After the breakup, however, I would prefer the new E&P company at least initially, until El Paso’s pipeline/midstream corporation proves that it can make money (while paying off its multibillion dollar capital investment) and maintain its status as an industry leader.
Swift Energy Company (SFY): This independent Houston-based company explores and develops oil and natural gas in 4 major areas of Louisiana and Texas. Shares appreciated 2.75% to $37.69 upon closing Tuesday, inching its way back from a gradual decline off its YTD high of $48.19 achieved in early February. SFY stock has a trailing P/E ratio of 27.7. The company has a market cap of $1.6 billion. In its Q1 financial report earlier this month, the company announced a net income of $20.2 million ($0.47 per diluted share), a 42% year-over-year increase from last year’s Q1 earnings of $14.2 million ($0.37 per diluted share). This was primarily driven by rising oil prices and increased production from the Eagle Ford shale play.
I believe SFY stock could be a good buy. With price target estimates averaging around $46.00, stock priced in the mid-$30 range is particularly appealing. SFY recently announced that its borrowing base was increased to $400 million by its ten-member bank group, yet the company elected to retain its current $300 million commitment instead—SFY has a history of funding its capital investments almost entirely with cash from its operations. Furthermore, the company made a deal with Southcross Energy GP in March to build a pipeline to its Eagle Ford property with an operating capacity of 90 million cubic feet of gas per day, which should be completed sometime this year. Given its commitment to sound financial practices and pushing the development of its 79,000 acres in the Eagle Ford share, SFY is poised for considerable growth, especially if it can capitalize on the summer’s sky-high oil prices.
That being said, much of SFY’s Q1 earnings were driven by these high oil prices. In the coming months, it will be interesting to see if the company will be able to step up production enough to compensate for falling oil prices and maintain its current level of profitability.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.